Hey Fools! Last Friday, I announced that I will be using my forthcoming weekly columns to examine the software industry in an attempt to identify both established and potential Rule Makers in what I believe is a target-rich environment. High gross and net margins, low Flow Ratios, and low capital expenditures are just a few of the advantages making the software industry's economic model so appealing. Part of my professional background is in the software industry, but nevertheless, I happen to be something of a computer idiot. Aside from my specialized niche in financial risk management software, this is not an industry I know particularly well. It is, however, an industry that I want to learn more about. I have no intention or expectation that what we find will result in any action in our online portfolio, but hopefully we will all be able to grow our knowledge of this attractive industry along the way.

This will be kind of an open-ended project. As long as we are making headway toward learning about the various sectors, companies, and investing in general, I'll continue with our theme. If it gets boring, repetitive, or the information starts to become so specialized as to lose relevance with the majority of investors, then it will be time to stop and re-assess whether there might be more benefit in talking about something else. I also have no preconceived notions about where this will lead, and hopefully you will indulge me if I take time here and there to jump off the trail when I catch the scent of something interesting. Since many of our readers work for, used to work for, worked with, worked on, or have gotten worked up over software companies or a particular software product that we discuss, please feel free to post your insights to our Rule Maker Strategies message board. Also, if you are aware of good sources of information on the software industry in general or a specific topic of interest, please post the website links.

So, where do we start? The software industry is very large and made up of numerous sectors. Among them, according to the Software Information Industry Association's website, are:

Packaged PC applications (the software that one buys at a store or online for personal or office use)

Operating systems for PCs and networked systems

Management tools for networks

Enterprise software, which enables efficient management

Software applications and operating systems for mainframe computers

Customized software for specific industry management

Since we'll be using our Rule Maker Criteria as our guide, we'll be looking for companies with dominant consumer brands and repeat-purchase business models, if possible. Therefore, we'll begin our search by looking at the packaged PC application software that many of us are already familiar with.

According to the association's website, here is the definition of packaged software: "Software written for mass distribution, not for specific needs of a particular user." That's what we want to find -- companies that crank out great software that the vast majority of PC users will find valuable, thereby spreading the cost of developing and supporting that software over millions of customers.

How big is the market for packaged software? According to the company that specializes in big numbers, International Data Corp., the total worldwide market for packaged software was over $140 billion in 1998, and is expected to grow at a 10-12% rate for the next several years. In the U.S., the market is estimated at about $30 billion, and the packaged software industry accounts for about 1% of GDP. Clearly, this market is big enough and is growing fast enough to support several Rule Maker companies.

To get a feel for the software makers on the market, I did what Peter Lynch recommends: I headed to the mall and checked out what's on the racks. I also cyber-perused at Amazon.com and Egghead.com. Finally, I checked out the software packages that reside on my PC at Fool HQ. Of the top 10 software sellers at Amazon, four were Microsoft products. The top seller when I checked was The Sims, a computer game from Electronic Arts. Other software titles were from Activision, Intuit, and Broderbund/Mindscape. On Egghead, the top sellers were significantly different, with the only constant being that Microsoft occupied four of the top 10 slots. Adobe, Corel, and Intuit were also in the top 10.

To separate the big dogs from the mutts, I checked out the companies in Media General Financial Service's application software classification. Out of the 134 companies, there were 11 that meet our minimum requirement of a $5 billion market cap:

Out of the 29 companies listed in Media General's Multimedia/Graphics software classification, there wasn't one that cracked the $5 billion barrier. The closest was Electronic Arts(Nasdaq: ERTS), at about $4.3 billion.

These are the initial candidates for our review. Of this group, I'd like to look at the ones that appear to be more mass consumer-oriented. Since we've had plenty of opportunity to learn about Microsoft over the past two years as a holding in our modest online portfolio, we'll start our examination with Adobe next week. After that, I'd like to take a long look at Electronic Arts. We'll put Intuit on hold for the moment, but I have every intention of coming back to it in the near future.

I hope you'll stick with me as we embark upon our software odyssey! For those of you who want to get a head start, please post any insights you have on the Rule Maker Strategies board.

NotesThe Rule Maker Portfolio began with $20,000 on February 2, 1998, and it added $2,000 in August 1998 and February 1999.
Beginning in July 1999, $500 in cash (which is soon invested in stocks) is added every month.